Bar Exam (Next Generation) Quiz: Shareholder And Member Litigation

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Shareholder And Member LitigationQuestion 1 of 11

A shareholder filed a derivative suit on behalf of Northstar Corp., alleging that Northstar's directors wasted corporate assets. The shareholder made a proper demand on Northstar's board before filing the suit. After discovery, the parties reached a settlement. The directors' insurer would pay $1 million to Northstar, the directors would surrender certain stock options, and Northstar would adopt new internal controls. The shareholder and directors asked the court to approve the settlement and to award attorney's fees from the settlement fund. Several other shareholders object, arguing that the settlement is inadequate and that they should be allowed to vote on whether to accept it.

Which issue is most likely to determine whether the settlement can take effect?

Whether the shareholder plaintiff made a demand on Northstar's board before filing the derivative suit.

Whether the court approves the settlement as fair to Northstar and adequate for its shareholders.

Whether a majority of Northstar's disinterested shareholders vote to ratify the settlement.

Whether the directors' insurer is obligated to pay under its policy.

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Bar Exam (Next Generation) Quiz

Bar Exam (Next Generation) Quiz: Shareholder And Member Litigation

Practice Shareholder And Member Litigation in Bar Exam (Next Generation) with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Shareholder And Member Litigation, giving you a quick way to practice the rules, question types, and explanations that matter most for Bar Exam (Next Generation).

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

All questions

Question 1

Which issue is most likely to determine whether the settlement can take effect?

Whether the shareholder plaintiff made a demand on Northstar's board before filing the derivative suit.
Whether the court approves the settlement as fair to Northstar and adequate for its shareholders. (correct answer)
Whether a majority of Northstar's disinterested shareholders vote to ratify the settlement.
Whether the directors' insurer is obligated to pay under its policy.

Explanation: In a derivative suit, the shareholder is asserting the corporation's claim, so the corporation—not the individual shareholder—controls the litigation. Whenever you see a proposed settlement of a derivative action, the central issue is whether the court will approve it as fair and adequate. That is exactly what determines whether this settlement can take effect: the court must find that the $1 million payment, surrender of stock options, and new internal controls are a reasonable resolution for Northstar and its shareholders. The court's role is protective because the real party in interest is the corporation. The demand on Northstar's board is not the determinative issue because the passage tells you a proper demand was already made; that requirement is satisfied. A vote by Northstar's disinterested shareholders is also not the deciding factor—derivative settlements cannot be ratified by shareholder vote to override judicial review; the court must independently assess fairness. Finally, whether the directors' insurer is obligated to pay may affect funding, but it does not control whether the settlement can take effect; even a funded settlement needs court approval. The objecting shareholders may argue inadequacy, but their remedy is to persuade the court, not to demand a shareholder referendum. Remember: in derivative suits, watch for court approval of settlements and fee awards—it is the procedural checkpoint that protects absent shareholders.

Question 2

Tamara, a shareholder of OmniBank, Inc., made a demand on OmniBank's board alleging that the CEO received an excessive bonus. The board rejected the demand, and Tamara filed a derivative action against the directors who approved the bonus. The board then created a special litigation committee (SLC) of two directors. One SLC member had served on OmniBank's audit committee when the bonus was approved but had no role in the bonus decision and owns only a small number of shares; the other SLC member is independent. The SLC hired separate counsel, reviewed more than 4,000 documents, and interviewed ten witnesses, but did not interview the employee who had first complained about the bonus. The SLC recommended dismissal, and OmniBank moved to dismiss.

Section 7.44(a) of the applicable corporation statute provides: "The corporation may move to dismiss a derivative proceeding if a committee of at least two independent directors determined in good faith, after conducting a reasonable inquiry, that maintaining the proceeding is not in the corporation's best interests." Section 7.44(b) provides: "A director is independent for this purpose if the director is not a party to the proceeding, did not participate in the challenged transaction, and has no material financial interest in the proceeding. Service on another board committee is not by itself a lack of independence." Section 7.44(c) provides: "If the corporation proves independence, good faith, and reasonable inquiry by a preponderance of the evidence, the court shall exercise its own independent business judgment on whether dismissal is in the corporation's best interests, giving appropriate weight to the committee's determination."

How should the court rule on OmniBank's motion?

Decide whether the SLC was independent, acted in good faith, and made a reasonable inquiry; if so, give weight to its recommendation but exercise the court's own independent business judgment. (correct answer)
Dismiss automatically if the court finds the SLC was independent and acted in good faith; the court may not substitute its business judgment for the SLC's.
Deny the motion automatically because the SLC failed to interview the complaining employee, making the inquiry unreasonable as a matter of law.
Deny the motion automatically because one SLC member served on OmniBank's audit committee, so the SLC was not independent.

Explanation: When you see a derivative action and a special litigation committee, the statute controls the standard. Section 7.44(a) lets the corporation move to dismiss, but the court is not a rubber stamp. The key is that the SLC's recommendation is persuasive evidence, not a binding verdict. The correct approach is to first verify the SLC's independence, good faith, and reasonable inquiry. Under Section 7.44(c), if the corporation proves those elements, the court must then exercise its own independent business judgment on whether dismissal is in the corporation's best interests, giving appropriate weight to the SLC's work. That is exactly what the correct answer says. So you should reject any answer that makes the court's role passive or automatic. The "dismiss automatically" choice fails because Section 7.44(c) explicitly requires an independent judicial business judgment, not automatic deference. The "deny automatically because the SLC failed to interview the complaining employee" choice is too rigid: reasonableness is assessed on the whole record—4,000 documents and ten interviews—not by any single missing witness. The "deny automatically because one SLC member served on the audit committee" choice is likewise wrong because Section 7.44(b) states that service on another board committee is not by itself a lack of independence, and that member had no role in the bonus decision and only a small shareholding. Your study tip: for SLC questions, remember the three-part test—independence, good faith, reasonable inquiry—plus the court's independent business judgment. Watch for "automatic" answer choices that try to convert a nuanced standard into a bright-line rule.

Question 3

Delta Components, Inc. is a publicly held corporation with a seven-member board, four of whom are outside directors. Chen, a shareholder, believes that Delta's CEO caused Delta to pay inflated prices to a supplier owned by the CEO's spouse. Chen made a written demand on Delta's board asking it to sue the CEO. The board appointed two of the outside directors to investigate the allegations. After reviewing the supplier transactions, the two directors concluded that pursuing Chen's claim was not in Delta's best interests and recommended that the suit be dismissed. Delta moved to dismiss Chen's lawsuit.

Which of the following facts, if true, would most strongly support Delta's motion to dismiss?

The supplier transactions were reviewed and approved by Delta's audit committee, which included the CEO as one of its members.
Chen made his demand on the board more than 90 days before the two directors completed their investigation and issued their recommendation.
Chen acquired and continuously held his Delta stock from a date before the supplier transactions began through the date he filed the lawsuit.
The two appointed directors were independent, had no role in the supplier transactions, and based their recommendation on a thorough report from independent counsel. (correct answer)

Explanation: This is a shareholder-derivative demand question. Once a shareholder makes a demand on the board and the board rejects the suit, courts generally review that rejection under the business judgment rule. So the decisive issue is whether the rejection decision was made by independent, disinterested directors acting in good faith and on a reasonable basis. The best supporting fact is that the two appointed directors were independent, had no role in the supplier transactions, and based their recommendation on a thorough report from independent counsel. That fact directly establishes the committee was disinterested and its process was reasonable, so Delta's motion to dismiss should prevail. It shows the board's rejection of Chen's demand was a legitimate business judgment, not a defense of the CEO. The wrong choices reveal common traps. The fact that the audit committee reviewed and approved the supplier transactions, with the CEO as a member, actually hurts Delta: approval by an interested director does not show the independence needed for business-judgment protection. The fact that Chen made his demand more than 90 days before the investigation was completed also does not support dismissal—statutes often let a shareholder proceed if a board takes too long, so delay would cut against Delta. Chen's continuous stock ownership from before the transactions through filing supports his standing as a shareholder, but standing is not a reason to dismiss on the merits; it helps Chen, not Delta. On exam, focus on whether the board's demand-rejection decision was made disinterestedly and on an informed basis—that is what makes a derivative suit dismissed.

Question 4

On April 1, the directors of Vista Corp. voted to issue 1 million new shares to themselves for one-tenth of fair market value. On June 1, Priya purchased shares of Vista from a longtime shareholder in a private sale. On July 1, after learning of the April 1 issuance, Priya demanded that Vista's board sue the directors. The board rejected the demand. Priya then filed a derivative suit seeking to rescind the stock issuance. The directors moved to dismiss, arguing that Priya could not maintain the suit.

Which issue is most likely to determine the outcome of the motion?

Whether the directors' self-dealing issuance of stock to themselves was a breach of fiduciary duty.
Whether Priya has standing to bring a derivative suit despite buying her shares after the challenged issuance. (correct answer)
Whether the stock issuance diluted the voting power of the shares Priya purchased.
Whether Priya's demand on Vista's board was made in good faith before filing suit.

Explanation: Whenever you see a derivative suit, separate the threshold issues—standing and demand—from the merits of the underlying claim. Here, the pivotal issue is the contemporaneous-ownership rule: a shareholder may bring a derivative suit only if she owned stock at the time of the challenged transaction. Priya bought her shares on June 1, but the directors' stock issuance occurred on April 1. Because she was not a shareholder when the alleged wrongdoing happened, she likely lacks standing to sue on the corporation's behalf. The choice about whether the directors' self-dealing was a breach of fiduciary duty goes to the merits, not to whether Priya may maintain the suit—even a meritorious claim fails if the plaintiff lacks standing. Similarly, whether the issuance diluted Priya's voting power addresses her personal injury, but a derivative claim must enforce corporate rights, not individual shareholder harm. And whether Priya made her demand in good faith is not the correct focus: the demand requirement asks whether she fairly demanded action or showed demand was excused, not whether her subjective motive was proper. For the bar exam, remember the timing trap: a later purchaser generally cannot bring a derivative suit for earlier misconduct. Check share ownership dates before analyzing fiduciary duties or demand.

Question 5

Petra owns 1% of Andalusian Holdings, Inc., which owns 80% of the voting stock of Sevilla Industries, Inc. Sevilla's five-member board consists of two Andalusian directors, one Andalusian vice president, and two directors unaffiliated with Andalusian. Petra sent a demand to Andalusian's board alleging that Sevilla's directors wasted corporate assets by purchasing property from an Andalusian director's spouse at an inflated price. Andalusian's board, after investigation by an independent committee, rejected the demand. Petra then filed a derivative suit on behalf of Sevilla against the Sevilla directors. She did not send a demand to Sevilla's board. The defendants moved to dismiss.

Section 7.52 of the applicable corporation statute provides: "A shareholder of a parent corporation may maintain a derivative action to enforce a right of a subsidiary if (1) the parent owns a majority of the subsidiary's voting shares; (2) the shareholder has made demand on the parent's board and the demand has been rejected or is excused; and (3) the shareholder has made demand on the subsidiary's board or demand on that board is excused. Demand on the subsidiary's board is excused if a majority of that board is composed of directors or officers of the parent, or is otherwise controlled by the parent."

Should the court dismiss Petra's action because she did not demand that Sevilla's board sue?

Yes, because a double derivative action requires demand on both the parent's board and the subsidiary's board, and Petra did not demand on Sevilla's board.
Yes, because only a shareholder of the subsidiary, not a shareholder of the parent, may sue derivatively for injury to the subsidiary.
No, because demand on Sevilla's board was excused: a majority of that board is composed of Andalusian directors or an officer, and Petra made the required demand on Andalusian's board. (correct answer)
No, because no demand is ever required before a parent shareholder sues on behalf of a controlled subsidiary; the parent's rejection binds the subsidiary.

Explanation: Whenever you see a double derivative suit, check the statutory elements: (1) parent owns a majority of the subsidiary's voting shares, (2) demand on the parent's board was made or excused, and (3) demand on the subsidiary's board was made or excused. Here Andalusian owns 80% of Sevilla, and Petra demanded on Andalusian's board, which then rejected the demand. The only issue is whether she also had to demand on Sevilla's board. Under the statute, that demand is excused if a majority of Sevilla's board is composed of parent directors/officers or is controlled by the parent. Sevilla has five directors: two Andalusian directors and one Andalusian vice president—three of five are parent directors/officers. So a majority triggers the excuse, and no demand on Sevilla is required. The court should not dismiss. The first wrong answer claims both demands are always required, but the statute expressly excuses the subsidiary demand in just this situation. The second wrong answer says only a subsidiary shareholder can sue, but the statute authorizes a parent's shareholder to bring a double derivative action on behalf of the subsidiary. The last wrong answer overstates, saying no demand is ever required; actually, demand on the parent's board is required and was made here, and the parent's rejection does not automatically bind the subsidiary. Study tip: for derivative suits involving parent-subsidiary structures, always count the subsidiary board's composition carefully—a majority of parent directors/officers is your trigger for excusing subsidiary demand.

Question 6

Two members own Maple Street Studios, LLC. Grace is the managing member; Henry is not involved in management. For the last two years, Grace made no distributions to Henry. Instead, she used the profits to renovate a building that she personally owns. Henry wants to sue Grace for his unpaid share of the profits.

Which of the following facts, if true, would most strongly support Henry's ability to sue Grace for his unpaid share of the profits?

Henry's share of the undistributed profits for the two years would have been approximately $120,000.
Grace also used LLC funds to pay for a personal vacation shortly after the renovation was completed.
The LLC's operating agreement gives Henry a contractual right to receive 60% of the LLC's annual net profits after expenses. (correct answer)
Grace has exclusive authority under the operating agreement to decide whether any distributions will be made to members.

Explanation: Whenever you see an LLC member suing for unpaid profits, separate two questions: what right does the member have to receive profits, and did the manager breach a duty. Distributions in an LLC are governed primarily by the operating agreement, not by a general default rule that all members automatically get paid annually. Here, the fact that the operating agreement gives Henry a contractual right to receive 60% of annual net profits after expenses is the strongest support. That language creates an enforceable entitlement: if profits existed and were not distributed, Henry has a direct breach-of-contract claim against Grace for withholding his agreed share. Now the distractors. Henry's share being approximately $120,000 only proves damages; it does not prove he had a legal right to that money. Grace's personal vacation shows she misused LLC funds, but that supports a fiduciary-duty claim for the LLC, not Henry's personal claim for his share of profits. The fact that Grace also used profits to renovate a building she personally owns is similarly a self-dealing problem, but again, the question asks about Henry's unpaid share, not general mismanagement. Finally, Grace having exclusive authority to decide distributions actually cuts against Henry: if distributions are discretionary and she has sole discretion, Henry has no automatic right to demand profits. Remember: in LLC law, contract terms beat default rules. Look first to the operating agreement for a clear distribution right before analyzing fiduciary duties or damages.

Question 7

Jasper is a member of Harborview LLC, which is managed by its sole manager, Chen. Jasper borrowed $50,000 from Priya and granted Priya a written assignment of all of his economic rights in Harborview—including rights to distributions and allocations—as security for the loan until repaid. Harborview's operating agreement provides that an assignee of an economic interest is not a member and may not exercise any member rights unless all members consent. No consent was given. After the assignment, Priya learned that Chen, before the assignment, caused Harborview to pay $75,000 to a company Chen owns for services that were never rendered. Priya filed a derivative action against Chen. She did not demand that Harborview sue Chen.

Section 405(a) of the applicable limited liability company act provides: "A derivative action may be maintained only by a person who is a member of the limited liability company at the time the action is commenced and who was a member at the time of the transaction of which the person complains." Section 405(b) provides: "A transferee of a membership interest, whether by assignment, pledge, or operation of law, who has not become a member may not maintain a derivative action." Section 405(c) provides: "Before maintaining a derivative action, a member must make demand on the managers requesting that the company pursue the claim, unless demand is excused because a majority of the managers are interested in the transaction or failed to pursue the claim after a reasonable investigation."

Should the court dismiss Priya's derivative action?

No, because the assignment gave Priya all economic rights, so she stands in Jasper's shoes; demand is excused because Chen is the sole manager and is interested in the challenged payment.
No, because Jasper's membership interest includes the right to sue derivatively, and the assignment transferred all economic rights to Priya.
No, because Priya, as a secured party, has the same right to enforce the LLC's claims as a member once the debt is in default.
Yes, because Priya is not a member, and an assignee who has not been admitted as a member cannot maintain a derivative action regardless of demand. (correct answer)

Explanation: This question tests the line between economic rights and membership rights in an LLC, especially for derivative standing. When you see a derivative action, your first question is always: does this plaintiff have statutory standing to sue on behalf of the company? Here, the LLC act is explicit: only a person who is a member at the time of the transaction and at commencement may bring a derivative action, and a transferee who has not become a member may not. Priya received only Jasper's economic rights—distributions and allocations—as security. She was never admitted as a member, and the operating agreement required all members' consent, which was never given. So she lacks derivative standing. Demand is irrelevant because standing is a threshold requirement; Chen's interest as sole manager cannot cure Priya's inability to sue. The wrong choices each blur that line. The choice saying the assignment gave Priya all economic rights so she "stands in Jasper's shoes" is wrong because derivative standing is not an economic right—it belongs only to members. Similarly, the statement that Jasper's membership interest includes derivative rights and that the assignment transferred all economic rights confuses economic benefits with governance and litigation rights. The claim that Priya, as a secured party, can enforce the LLC's claims once the debt is in default is also unsupported; a secured party has rights against collateral, not automatic derivative standing. Study tip: in LLC derivative actions, check standing before demand or merits. A nonmember assignee can never maintain a derivative action, no matter how strong the underlying claim.

Question 8

Delia, a shareholder of Beacon Corp., filed a derivative suit against Beacon's directors for wasting corporate assets by approving a $5 million signing bonus for the CEO. She did not assert any personal claim. During discovery, the board created a compensation committee and adopted a clawback policy. The parties then settled the derivative suit: the CEO agreed to repay Beacon $200,000, and Beacon adopted further governance reforms. The court approved the settlement as fair. Delia's counsel moved for an attorney's fee award of $400,000, to be paid by Beacon, arguing that the suit caused both the repayment and the governance reforms.

Section 7.46(c) of the applicable corporation statute provides: "In a derivative proceeding, the court may award reasonable attorney's fees to the plaintiff only to the extent the proceeding resulted in (i) a common fund for the corporation or (ii) a substantial nonpecuniary benefit to the corporation that is causally related to the filing and prosecution of the suit. Fees may be paid from the common fund or, for a substantial nonpecuniary benefit, by the corporation. The possibility that the suit prompted corporate action is not alone sufficient."

How should the court rule on Delia's fee motion?

Award fees from the $200,000 common fund and, if that is insufficient, against Beacon for the reforms only if Delia proves the suit was a substantial factor and the fees are reasonable. (correct answer)
Deny fees entirely because the repayment merely restored money the corporation never should have lost, so no common fund was created, and the governance reforms are speculative.
Award fees from the $200,000 repayment only, because the statute does not authorize requiring Beacon to pay fees in addition to a common fund.
Award the full $400,000 against Beacon because the suit was the but-for cause of the repayment and the board would not have acted but for the litigation.

Explanation: In a derivative suit, attorney's fees are an exception to the usual "each side pays its own fees" rule. The statute allows fees only if the suit produced a common fund or a substantial nonpecuniary benefit, and the plaintiff must show the suit actually caused that benefit—not just that it possibly prompted corporate action. Here, the $200,000 repayment is a concrete common fund, even though it merely restored money the corporation should not have lost. The governance reforms can also support a fee award, but only if Delia proves they were a substantial nonpecuniary benefit caused by the suit as a substantial factor, and that the requested fees are reasonable. The court should first look to the $200,000 fund, then may award additional fees against Beacon for the reforms if the fund is insufficient. "Deny fees entirely" is wrong because the repayment is a common fund, and the reforms are not automatically speculative—they must be proven. "Award fees from the $200,000 repayment only” is wrong because the statute expressly authorizes the corporation to pay fees for a substantial nonpecuniary benefit. “Award the full $400,000 against Beacon" is wrong because but-for causation alone is not enough; the statute requires substantial-factor causation and reasonableness, and fees are limited to the extent of the benefit. On exam questions like this, look for the statutory trigger words: common fund, substantial nonpecuniary benefit, substantial factor, and reasonableness.

Question 9

Rosa owns 40% of the shares of Blanca Corp., a close corporation. Victor owns the remaining 60% and manages Blanca. Without Rosa's consent, Victor caused Blanca to sell its only factory to a company owned by Victor's brother for one-third of fair market value. Victor then stopped declaring dividends, telling Rosa that Blanca had no cash. Rosa wants to sue Victor to recover the lost value of the factory and to require Blanca to resume paying dividends.

Which of the following is the most significant legal issue raised by Rosa's proposed suit?

Whether Rosa's claim should be treated as derivative on behalf of Blanca or direct against Victor. (correct answer)
Whether Victor, as the majority shareholder of a close corporation, owes fiduciary duties to Rosa.
Whether Blanca's board must be joined as a party to Rosa's suit.
Whether the sale of the factory to Victor's brother breached Victor's duty of loyalty.

Explanation: Whenever a shareholder complaint alleges harm to the corporation plus harm to the shareholder, ask first: who owns the right to sue? A claim that corporate assets were sold below market is a corporate injury, even in a close corporation. The controlling shareholder's self-dealing may be a breach of fiduciary duty, but the loss is to Blanca; any recovery for the factory's value generally belongs to Blanca and must be pursued derivatively, unless state close-corporation law permits a direct action under special circumstances. The dividend-stoppage claim, by contrast, may be direct because it harms Rosa as a shareholder. Thus the threshold question is whether Rosa's suit is derivative, direct, or a mix; that classification controls standing, procedural requirements, and who recovers. The claim that Victor, as majority shareholder, owes fiduciary duties states a true rule but skips the threshold issue: the existence of the duty is not the contested question, and proving a breach would still require deciding who may enforce it. The board-joinder option confuses the corporation with its board; a derivative suit must join the corporation as a party, but individual directors generally need not be joined. The sale-to-Victor's-brother option describes the underlying wrong, not the most significant legal issue, because proving the sale breached Victor's duty of loyalty does not resolve whether Rosa can sue directly. Study tip: when a shareholder alleges majority misconduct, first classify the injury—corporate or direct—before discussing fiduciary duty.

Question 10

Abby owns 20% of the shares of Sequoia Consulting Corp. Under a shareholders' agreement, Abby has a contractual right to purchase enough shares in any new issuance to maintain her 20% ownership. The articles of incorporation contain no preemptive rights. Without notifying Abby, the board—controlled by the majority shareholder—issued a large block of shares to the majority shareholder at a deep discount, reducing Abby's ownership to 5%. Abby filed an action asserting two claims: (1) breach of the shareholders' agreement for failing to offer her the shares, and (2) breach of fiduciary duty and corporate waste for issuing shares below fair value. She did not make a demand on the board.

In re Monarch, the applicable appellate decision, held: "A claim is derivative if the primary injury is to the corporation and the shareholder's injury is indirect. A claim is direct if the shareholder alleges breach of a contractual right owed directly to that shareholder, such as a preemptive right created by agreement, and the injury to the shareholder is independent of the corporation's loss. When a complaint alleges both a direct contractual injury and a separate corporate injury, the court may allow the direct claim to proceed while requiring the shareholder to comply with derivative procedures for the corporate claim."

Which statement best describes how the court should treat Abby's two claims?

Abby's action is entirely derivative because the below-market issuance primarily injured the corporation and Abby's loss is only a reduction in the value of her shares.
The breach-of-agreement claim is direct and may proceed; the corporate-waste claim is derivative and may not proceed unless Abby makes demand or shows demand is excused. (correct answer)
The breach-of-agreement claim is direct, but Abby must still make demand before pursuing it because the claim arises from board action on a new issuance.
The breach-of-agreement claim is derivative because the contractual right to maintain proportional ownership is held for the benefit of all shareholders, and the corporate-waste claim is derivative because the corporation was the primary victim.

Explanation: Whenever you see a shareholder claim, first ask: who suffered the primary injury, and is the asserted right owed directly to this shareholder? That distinction controls direct versus derivative treatment. Here, Abby's first claim is for breach of the shareholders' agreement. That agreement gave Abby a personal contractual right to purchase shares in a new issuance to maintain her 20% stake. Because the board failed to offer her the shares, the injury is to Abby's contractual entitlement, independent of any corporate loss. Under the rule in In re Monarch, that claim is direct and may proceed without demand. Her second claim, for breach of fiduciary duty and corporate waste, is different. Issuing shares below fair value primarily injures the corporation by diluting its value and transferring wealth at the corporation's expense. Abby's resulting drop in ownership percentage and share value is indirect. That claim is derivative, so she must make demand on the board or plead with particularity why demand is excused before proceeding. The choice saying the entire action is derivative ignores Abby's separate contractual right. The choice saying the contract claim is direct but still requires demand confuses derivative procedure with direct claims. And the choice treating the contractual right as held for all shareholders misreads the agreement—the right was personal to Abby, not a general preemptive right. On exam day, separate the claims: personal contract breach = direct; corporate value loss = derivative, requiring demand.

Question 11

Evan owns 2% of Northwind Manufacturing Corp. He filed a shareholder derivative suit against three of Northwind's five directors, alleging they approved the sale of a Northwind factory to Javelin Industries—a company controlled by Northwind's CEO—at 40% below fair market value. Evan did not make a demand on any director or committee before filing. Northwind moved to dismiss. Northwind's bylaws require every derivative demand to be submitted to the standing Audit Committee, which has two members, is authorized to decide whether Northwind should pursue the claim, and is composed of directors who are not officers of Northwind and have no interest in Javelin. Both Audit Committee members are independent.

Section 7.42(a) of the applicable corporation statute provides: "A shareholder may not commence a derivative proceeding until 90 days after making demand on the directors, unless the demand has been expressly rejected or irreparable injury to the corporation would result from waiting." Section 7.42(b) provides: "Demand is excused only if the shareholder alleges with particularity that a majority of the directors who would consider the demand are not disinterested and are not independent, and that the challenged transaction was not the product of a valid exercise of business judgment."

Should the court grant Northwind's motion to dismiss?

No, because a majority of the full five-member board was interested in the challenged transaction, so demand on the board would have been futile.
No, because the complaint alleges a sale at 40% below market, which cannot have been a valid exercise of business judgment, so demand futility is established.
Yes, because the directors who would consider the demand are the two independent Audit Committee members, and Evan neither made demand nor showed that demand would be futile or that irreparable injury would result from waiting. (correct answer)
Yes, because Evan sued three of the five directors, and the Audit Committee is not authorized to bind the full board on litigation decisions.

Explanation: When you see a shareholder derivative suit, the first question is always: to whom must demand be made, and was it made? Under Section 7.42(a), a shareholder must make demand and then wait 90 days, unless demand is rejected or waiting would cause irreparable injury. Section 7.42(b) excuses demand only with particularized facts showing that a majority of the directors who would consider the demand are interested or dependent and that the transaction was not a valid business judgment. Here, Northwind's bylaws route every derivative demand to the two-member Audit Committee, and both members are independent and disinterested. Because Evan made no demand and alleged no irreparable injury, the court should dismiss. The "majority of the full five-member board was interested" argument misfires: demand is not measured against the whole board when bylaws designate a committee to consider it. The "40% below market" argument also fails—a low sale price alone is not enough to prove the absence of business judgment, and Evan did not allege particularized facts about the Audit Committee's disqualification. Finally, the claim that the Audit Committee "is not authorized to bind the full board" is beside the point; the committee is authorized to decide whether Northwind should pursue the claim, so demand was required there. Study tip: in derivative suits, identify the demand panel first. Statutes and bylaws may create a committee, and futility is measured against that panel—not the full board. Then check demand, futility, and irreparable injury before examining the merits.